Eight reasons bankers and Fintech upstarts are “up at night” about Compliance

By Bernard Lunn

Compliance is a big ugly problem and it’s getting worse and nobody has nailed it yet.

That should have entrepreneurs salivating.

Investors say,

“show me compliance deals”.

Bankers say,

“show me a solution”.

Startup founders say,

“we must spend our precious cash on lawyers and regulatory experts”.

Nobody loves compliance. Everybody hates compliance. So it’s a massive opportunity.

Looking at the usual Fintech lists and accelerators, the compliance breakthroughs do not leap out of the pixels. The usual searches turn up lots of lawyers and outsourcing firms willing to throw man hours at the problem, but that hardly counts as a breakthrough solution.

With such huge demand, the lack of supply means that it must be a very hard problem to solve. This needs more than your average app coded in a few Red Bull fueled weeks. This is more like a breakthrough in drug discovery or clean energy – demand is massive, but it is technically tough to solve.

Here are the 8 reasons why compliance is so hard:

1. Compliance is a moving target. Since the Financial Crisis we have had lots of new regulations and lots of new scandals (which triggers new regulation). At the same time we have Bitcoin, which is totally uncharted territory.

2. Compliance is a territorial smorgasbord. Finance is a global business and “bits don’t stop at borders”. However, money does stop at borders and each country has its own spin on regulation.

3. Compliance is an easy lever for politicians to pull. Beating up bankers is an easy vote catcher and the negatives from too much regulation are not so visible and causation is unclear.

4. Compliance is a cross cutting concern. Compliance cuts across every system, including ones written before most of today’s regulation was even a gleam in the eye.

5. Compliance does not have a revenue line attached. Despite the massive risk posed by compliance failure, there is no revenue line where a banker can grab budget from.

6. Compliance is an existential threat. Get it wrong and you could literally be gone tomorrow. So, nobody loves spending money on compliance, but you have to spend money on it.

7. Perfect Compliance is a recipe for never getting out of bed. Perfect compliance is simple. If you don’t do any business, you won’t have any compliance risk. If you don’t get out of bed, you won’t get run over by a bus. You are “damned if you do, damned if you don’t”.

8. Compliance is functionally complex. There are so many areas to understand and each is horribly complex on its own –  Money Laundering (KYC), Tax (FATCA), Consumer Protection, Data Privacy, Systemic Risk (Dodd Frank). Add them all together and it is a recipe for sleeping like a baby (wake every few hours screaming).

Daily Fintech Advisers provide strategic consulting to organizations with business and investment interests in Fintech.

Two more things that London needs to become the Fintech Capital of the world.

Bitcoin is the most fundamental innovation driving Fintech and I have already opined why London is emerging as the Bitcoin Capital of the world.

However Bitcoin and the Blockchain (and Sidechains) are the bottom of the tech stack. What matters is, who will build multi-$ billion enduring Fintech startups (which may or may not use Blockchain technology as part of their stack)?

Today, the global leaders in most categories are still American. For P2P Lending, think Lending Club and Prosper. For Crowdfunding, think Angel List and Kickstarter. Some great success stories are emerging out of London, but most of the big scores are still from America.

Most of the pieces are already in place for this to change in London – smart regulation, great angel tax incentives, big VCs moving in, some great ventures scaling fast, superb accelerators, a big market in Europe that is actually more unified than America when it comes to Financial Services and a natural place at the cross roads of Asia and America time zone wise, travel wise and culturally. However I see two more things that London needs in order to hit the big time:

1. Lead Angels looking for Unicorns, who create Angel List Syndicates.

2. An IPO market that attracts global investors.

Let me unpick those two points:

Lead Angels looking for Unicorns, who create Angel List Syndicates.

– Lead Angels. Ask any experienced entrepreneur what drives them most crazy about the fund raising process and you are likely to hear something like this:

“I wasted huge amounts of time pitching investors who will only follow another investor, but won’t take the lead.”

Unicorns = big global winners valued in $ billions. Silicon Valley is a unicorn breeding ground. We are seeing more in Europe (Skype and ARM were the only unicorns we could reference for a long time). However the ambition level of most UK entrepreneurs and investors has been limited to “enough to get a vicarage and a fast car” (quote from Edmund Truell).

– Angel List Syndicates. These are still rare in Europe but they are changing the early stage funding game in Silicon Valley and will soon do so here. For background read yesterday’s post on Crowdfunding and, if you don’t already know Angel List, check it out. The big deal about Angel List is how they incentivize the Lead Investor.

An IPO market that attracts global investors

Today that means NYSE or NASDAQ. There is no reason why it should not be London. If you are an entrepreneur in middle America who succeeds in creating a unicorn, you:

  1. Raise your Seed round locally,
  2. Travel to Silicon Valley to raise big private money
  3. Travel to NY to do your IPO

London can do 1 and 2 locally, but the unicorn still jumps on Virgin Atlantic to go to NY for the IPO. The reason proudly European entrepreneurs go to NY for the IPO is the same reason that Willy Sutton robbed banks – it is where the money is. You need that money and you need the branding event in America.

If a London IPO means you only get UK or other European investors, it is doomed to be a minor exchange. There is no reason why US or Asian investors would not buy stocks on LSE. Hedge Funds and Family Offices (the two fastest moving pools of capital) are quite comfortable investing globally.

Investors don’t care which exchange they buy and sell on, as long as it is reputable and competitive (LSE clearly scores on both points) and the data is easily accessible. Making the data more accessible is the reason why I keep banging the XBRL drum).

The Crowded Crowdfunding Landscape

Crowdfunding sites are popping up like mushrooms – or like social networking sites in the 2004-2007 era.

I don’t think it will consolidate down to quite such a small end list as social networking, but it will be pretty close. Network effects businesses always tend towards a winner takes all result.

Regulatory barriers by country may slow this consolidation. However, I suspect that America will set the regulatory benchmark and that countries will either be ahead or behind that benchmark temporarily.

Networking sites don’t usually grow via big acquisitions. For the winners, that happens organically and virally.Networking sites buy bolt-ons to accelerate technology feature deployment, but those are typically small acquire-hires. So, I don’t see this as a market where the geographic clone game works.

However there is room for different models. Even in social networking, after brutal consolidation, we have Facebook and LinkedIn and Twitter. Crowdfunding is a complex business where devil lurks in details, so one size won’t fit many people.

Today I see 6 fundamental models:

  1. Perks and products. Kickstarter and Indiegogo rule and it is hard to see any new entrants getting traction. The Oculus deal, where the founders got $2.4m without any dilution, was a game-changer that many entrepreneurs want to copy.
  2. Matching sites where the investor pays. AngelList rules and I think they have nailed the model through incentivizing the lead investor. They are weak outside America for now, but methinks this is temporary.
  3. Matching sites where the entrepreneur pays. This is the norm in Europe today, because historically Europe has had a shortage of early stage capital. There is room for both models, but with the rapid growth of early stage money in Europe I think we will see the Angel List model take hold. However while this is true for high trajectory/high risk startups, the entrepreneur pays model may work in the much larger market of traditional “butcher, baker and candle-stick maker” businesses.
  4. Private Deal Rooms. These are less to do with discovery and matching and more to do with deal facilitation between parties that already know each other. These have to be functionally rich and they are less subject to network effects; so I expect these will be acquired by the network winners.
  5. Private Debt Marketplaces. I have covered this in other posts, so nothing to add except that both entrepreneurs and investors weigh both debt and equity options, so I see debt as part of the crowdfunding landscape.
  6. Virtual Currency. Something like Ethereum’s $14m raise for seed stage technology may be a one of a kind event. However I expect to see more innovation in this area.

The poker mantra is:


“If you don’t know who the sucker at the table is, it is probably you.”


Crowdfunding today is too focused on FOMO (Fear Of Missing Out). You read about the latest billion dollar round or hot IPO and then see something that looks vaguely similar where you can buy in really cheaply.

The answer to democratizing equity markets is to use XBRL to make small cap public stocks more accessible. It is not to drive investors to be the suckers in the early stage investing game.

The early stage math is merciless. 90% of startups fail. So you invest in enough that you will get the one rocket ship that gets to $ billion exit. That is how VCs work, why not do the same? That math just gets more merciless. Out of the 10% that do NOT fail, 90% of those won’t get to that $ billion exit. So you have to invest in a lot of Wonka bars to get a shot at the one golden ticket.

When you do get that one golden ticket, new problems start. The big money that comes in at that point has no obligation to look after your needs. You get crammed down, unless you can write really big checks at nose bleed valuations. Not all of those big nose-bleed valuation rounds turn into actual exits at valuations above the last round. Suddenly, what started as a low cost bet on the future becomes a big investment.

There is one crowdfunding model that looks good to me and that is Angel List. The idea of just following a star investor makes sense. You can select stars by domain, so that you get some sector diversity. If you can see that Investor X has a great Track Record in Sector Y, you can invest alongside Investor X. You might even find that you really know Sector Z and become a lead in that market.

Angel List is a game-changer because it focusses on remunerating the lead investor. Finding the lead is the whole game for entrepreneurs – lots of investors who are interested in being followers is just a time suck.

Angel List works for the Lead because they get paid like a VC without the hassle of raising and managing a VC fund. It works for the Backers (investors who Follow) because the difference between a good deal and a bad deal is massive at the early stage (like the difference between losing 100% and gaining 10x), so following somebody who knows what they are doing is the only smart way to invest. That is not true in public markets where the difference between say IBM or HP as an investment is fairly minor.

So, while I think most crowdfunding is for suckers, I think Angel List is onto a winner and that they could change the early stage investing landscape.





Facebook Ambitions in Fintech

This is the last of a series that looks at the big dog ambitions in Fintech. So far I have covered Google, Alibaba and Apple. (I have not covered Amazon as I have not discovered any major moves yet – please tell me if I have missed something).


Speculation alert: Facebook has not yet made their big move in Fintech.


The big Facebook question is:


“Will Facebook monetize WhatsApp by adding payments?”


Facebook won’t monetize WhatsApp with advertising. It is not just that they promised not to, it is that text messaging is a lousy ad platform unless you get spookily far on the wrong side of privacy.


At $1 per user per year, there are not enough people on this planet (about 7 billion) to recoup that $19 billion investment from subscriptions and many people would switch to a free service (remember for a lot of those 7 billion people, $1 is quite a lot of money).


Mark Zuckerberg is a smart guy. He must have a plan and the only one that makes sense is payments. Facebook already has virtual currency, so it’s a simple step to let people send that currency to each other using WhatsApp.


That would put Facebook slap bang against Bitcoin – a different virtual currency with a different payment network. I don’t see anything like a distributed ledger in Facebook or WhatsApp.


So far we only have rumors and speculation, but most people that I speak to assume that Facebook will get into payments. The rumors intensified when Facebook poached David Marcus from PayPal.



Apple Ambitions in Fintech

This is one of a series that looks at the big dog ambitions in Fintech. I started with Google and then I looked at Alibaba.


Apple Pay is game-changing for a very specific reason. It is not disruptive. Apple Pay plays nice, nice with the existing payments giants. Nor does it use any amazing new technology.


Apple Pay is game-changing because it will change user behavior. The combination of three things will ensure that waving your phone at a check-out will feel pretty normal:


  1. Apple gets the user experience right
  2. Apple is a trusted brand
  3. Apple has the clout to get partners on board


This is what Apple did with iTunes. Napster blew up the music business model with free and illegal. iTunes reaped the reward with cheap, easy and legal. Bitcoin is blowing up the payments business model with free and outside the system (sometimes legal, sometimes not) and Apple Pay may reap the reward with cheap, easy and legal.


Apple Pay is ideal for physical stores. That leverages the fact that you “don’t leave home without your phone” (remember that Amex ad). Apple Pay does not really add any value in e-commerce, which is where Bitcoin is gaining more traction.


Next up (tomorrow) is Facebook’s Ambitions in Fintech.

The fast money moving into P2P lending and the danger of another subprime meltdown

Hope springs eternal, but math is merciless.

Financial innovation makes us hope for better outcomes for all. We hope that the securitization of mortgages leads to more people being able to afford to own their own homes. Seven years after the subprime mortgage meltdown, we hope that P2P Lending will enable people and small businesses to “make ends meet”.

That is the hope and the hope is always based on a hypothesis that has enough truth for it to be credible.

It is hard to remember that Countrywide Financial was once seen as an innovator that was bringing down the cost of mortgages for poor people. Hindsight is always 20/20.

The hopeful hypothesis in the P2P Lending story is that by automation and cutting out the spreads charged by banks, we can dramatically reduce the cost of borrowing money. When financial institutions can borrow at “almost zero cost” in our central bank driven Zero Interest Rate Policy (ZIRP) and we can let machines do the hard work of credit analysis at almost zero cost, why should consumers and small businesses pay such high rates?

The simple populist answer is always “banker greed”.

The reality is more complex. Credit analysis is complex. Lending has limited upside and lots of downside, so the math has to be right. In equities, you get big upside with the big downside risk, so it is less about math and more about potential in technology, markets and management. Lending is easy when the data is there, as it is for mainstream consumers that have a healthy FICO score and as it is for Corporate Bonds. It is much harder in markets where lenders cannot simply plug in a credit score from companies such as FICO, Moodies and S&P into their models. These are hard data problems and complex algorithms.

For the Alternative Finance P2P marketplaces, the math is still merciless. If a consumer is poor and cannot make it from payday to payday, the credit risk is tough. That merciless math has already brought Wonga into the headlines in a bad way. The reality for many bricks and mortar retailers and Merchant Cash Advance companies is equally tough.

Alternative Finance P2P marketplaces cannot solve the fundamental problems in the economy. However, because of the popular hope created by these marketplaces, the sentiment and brand damage when those hopes are dashed will be dangerous for those marketplaces (and will lead to more regulation).

The simple takeaway from the Subprime Mortgage blow out was:

“It’s the Transparency, Stupid!”

Or to be more accurate, it was the lack of transparency. Lenders were being asked to trust credit rating labels that were paid for by the firms selling the loans. Actually the data was there, but many lenders chose to simply trust a surface rating rather than do the hard analysis.

As the Who sang: “Won’t get fooled again”

Institutional Lenders that lend into Alternative Finance P2P marketplaces now do the hard analysis and the marketplaces give them the tools to do this. Marketplaces want transactions but they are also fully aware that too many bad transactions will put their business in peril.

So, hope does spring eternal. Data can solve the problem because economic incentives are aligned to that.

However the danger lies in the P2P part of Alternative Finance P2P marketplaces. This was how the concept originated, but the reality today is that the lenders are mostly institutional funds. The retail lender can be divided into two types:

  • “Day Lenders”.They are like the day traders in the late 1990s and they are as savvy as the institutional lenders, with high speed trading rigs, tech and data analysis skills and a tough, fast moving trading mentality.This article from Lending Memo is good at explaining how they work. TL;DR summary, make sure you know how to code to an API. High Frequency Trading (HFT) sidelined the day traders, because they could not afford the co-located servers at the Exchanges. In Feb of this year, the FT reported on Lending Club and Prosper installing “speed bumps” (paywall link) in order to prevent this happening to P2P lending.
  • Retail Investors looking for extra income. The average consumer sees a headline rate and a credit badge put on by the marketplace and is so excited by that compared to what they get from a bank, money market fund or bond funds that they ignore the mandatory small print warnings. This is where a subprime mortgage type meltdown risk lurks.

Alternative Finance P2P marketplaces are currently in the fast money phase.

This is the world of Hedge Funds and tech savvy retail traders. They are are doing well on these marketplaces because the markets are still inefficient and opaque. They are arbitragers and that is a good business that rewards those who are fast, tech savvy, smart and tough. That is a good phase to go through. The next phase is where the big and more patient money will come in and that will bring down interest rates and the arbitragers will move onto the next inefficient and opaque marketplace. Efficiency, transparency and regulation is the big win for the Alternative Finance P2P marketplaces because they don’t care about the actual interest rate; all they care about is the volume of transactions from which they make their fee.

The upcoming IPO of Lending Club is bringing lots of new money into new marketplaces. Not all of them will be equally vigilant about protecting both sides of the marketplace. Most of them will fail because marketplaces always consolidate down to a few big ones (think NYSE vs NASDAQ). The danger to the whole ecosystem is that some nasty scandals from some unscrupulous players bring the whole concept into disrepute.





Alibaba Ambitions in Fintech

Bits don’t stop at borders. Bits also don’t stop at category boundaries. Retailers and banks both serve consumers and process payments. For most of the 20th century retailers and banks were partners. In the 21st century digital age, both have to get used to the more complex cooptition reality. Bankers have long worried about WallMart moving into banking. So far that has not happened. Nor has Amazon decided to eat the bank’s lunch, yet.

However Alibaba is not holding back. Their ambition level is staggering. We used to talk about the 4 horsemen of the Internet – Google, Amazon, Apple and Facebook. Alibaba has to join their ranks if you look at any metric such as revenue, profit, or market capitalization. So one horse has to get the boot or we have to drop the 4 horsemen label.

Forget the Amazon of China label for Alibaba. The label of “Amazon plus eBay plus PayPal of China” alone does not recognize their global ambitions.
Alibaba is a fierce competitor. Obviously they have the scale, the balance sheet and the ambition. There is a complacent view in Silicon Valley that “yes, but, they lack innovation”. In Fintech, Alibaba sure looks innovative enough and they have the clout to pull it off.

Alibaba kept Alipay outside their IPO; that probably made it easier to avoid an excess of regulatory scrutiny. However make no mistake that this is one company controlled by a hugely determined entrepreneur.

A few weeks ago I first noticed Alibaba moving into money market funds.

It looks like Jack Ma is not satisfied with the biggest tech IPO in America. Tick in the box on that score. Now he seems to also want the biggest IPO in China. The newly branded Ant Financial combines 6 entities into one:

  1. Alipay (think PayPal)
  2. Alipay Wallet (190 million active users)
  3. Ue’e Bao (the money market fund)
  4. Zhao Cai Bao (lending marketplace)
  5. Ant Credit (microfinance)
  6. MY Bank (full stack bank)

It looks like Ant Financial will do an IPO in China, which makes sense, because they won’t be offering financial services in the West, yet. However I am sure that the “four original horsemen” will be watching these moves carefully. Methinks this could trigger some mega M&A deals; the i-bankers are probably salivating. PayPal is clearly in play. Which means eBay is also in play. Amazon, Google, Facebook and Apple all have the balance sheet and ambition to buy both PayPal and eBay.

Ant Financial will probably follow a First The Rest, then the West strategy. They will win first in emerging markets and then they will go for America and Europe. Given the huge potential of the unbanked this makes sense. Also low cost finance is a great enabler for cross border razor thin margin e-commerce, so having both e-commerce and Fintech controlled by one entity make sense as well.